Draghi sounds alarm on Europe’s productivity
A host of factors have conspired to act as a brake on Europe’s economic growth this century. And the situation is not helped by inherent difficulties with financing the necessary measures to increase productivity.
Since the beginning of the century, European policymakers have looked on the continent’s slowing economic growth with concern. The situation is particularly pronounced when compared with the superior growth rates achieved by the US over the same period. On a per capita basis since 2000, real disposable income has grown almost twice as much in the US as in the EU.
For much of this time, however, Europe’s weak performance was masked by a largely favorable global economy. This was a period of vigorous world trade facilitated by expanded multilateral trading rules and a generally stable geopolitical backdrop. The US security guarantee also allowed European nations to reduce defense spending, providing a windfall that cushioned Europe’s structural issues.
Productivity boost required to reignite growth
But that era is now over. Russia’s invasion of Ukraine has brought an abrupt end to the stability Europe once enjoyed, cutting off its largest energy supplier and exposing deeper vulnerabilities. Europe continues to trail the US in technology, with just four of the world’s top 50 tech companies located in Europe. Meanwhile, unfavorable demographic trends – most notably, a projected annual workforce decline of two million people – underscore the urgent need to boost productivity.
It was against this backdrop that former ECB Chair Mario Draghi was tasked by the European Commission to prepare a report with the title The Future of European Competitiveness. The report is intended to contribute to the Commission’s work on a new plan for Europe’s sustainable prosperity and competitiveness, with a particular focus on the development of the new Clean Industrial Deal, which will be presented in the first 100 days of the next Commission mandate.
While Draghi’s report recognizes the EU’s continued “general strengths” such as sound education and health systems, along with robust welfare states, it also highlights Europe’s failure to convert these strengths into productive and globally competitive industries.
Draghi has identified three areas for action to reignite sustainable growth.
1. Closing the innovation gap:
Europe cannot seem to produce companies capable of disrupting existing industries or developing new “growth engines.” No EU company set up from scratch in the last fifty years has reached a market capitalization of over EUR 100 billion.
By contrast, all seven US companies valued above EUR 1 trillion were created during this period. European companies invest less in R&D, and many entrepreneurs look to US venture capitalists for financing, often scaling their businesses in the US market. Between 2008 and 2021, close to 30% of Europe’s unicorns (startups that went on to be valued at over USD 1 billion) relocated their headquarters abroad, with the vast majority moving to the US.
2. Decarbonization and competitiveness:
Europe suffers from a lack of natural resources and has fundamental issues with its common energy market. Electricity prices for EU companies are two to three times higher than in the US, while natural gas prices are four to five times higher. The failure of industries and households to capture the full benefits of clean energy in their bills is attributed to market rules. The EU needs a plan to transfer the benefits of decarbonization to end-users, otherwise energy prices will continue to weigh on growth.
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And while decarbonization is an opportunity for Europe – the EU is a world leader in clean technologies like wind turbines and low-carbon fuels, while it also develops more than one-fifth of clean and sustainable technologies – it is threatened by China, which deploys industrial policy, subsidies, control of raw materials, and large-scale production to outcompete Europe.
3. Increased security and reduced dependencies:
According to Draghi, security is a precondition for sustainable growth. The EU needs a foreign economic policy with more extensive partnership networks to secure supply chains coupled with increased military spending via a consolidated defense industry.
Mario Draghi. Source: Tovima
Financing constraints
Financing a reset of the European economy is a daunting prospect. It would require a minimum annual additional investment of EUR 750–800 billion to meet the objectives set out in the Draghi report, a sum corresponding to 4.4–4.7% of EU GDP in 2023 (investment under the Marshall Plan between 1948–1951 was equivalent to 1-2% of EU GDP).
A major sticking point is that productive investment in the EU is weak, despite “ample” private savings. Consequently, the report devotes considerable attention to the root causes of low investment financing in Europe – and the causes are familiar. One of these is the fragmented nature of European capital markets, meaning that the flow of savings into capital markets is relatively low. The Commission’s efforts to build a Capital Markets Union (CMU) and Banking Union face major obstacles such as:
- The lack of a single securities market regulator and rulebook for trading, with inconsistent supervision and interpretations of regulations
- A far less cohesive post-trade environment for clearing and settlement compared with the US
- Unaligned tax and insolvency regimes across the EU
The report also notes that EU capital markets are undersupplied with long-term capital relative to other major economies, due mainly to the underdevelopment of pension funds.
EU’s over-reliance on bank financing
A consequence of the above issues is that the EU relies excessively on bank financing, which is less well-suited to funding innovative projects, while carrying several constraints. The completion of the CMU should go a long way toward addressing these shortcomings. In this context, the report advocates for joint EU funding of “European public goods” such as infrastructure and defense, as well as the issuance of a common safe asset.
Benefits of a common safe asset for European financing
Joint EU funding seems unfeasible right now due to the likely objections of more frugally-minded states. At the same time, there is no doubt – according to the report – that the issuance of a common safe asset would make the CMU much easier to achieve and more complete, for several reasons.
First, such issuance would facilitate the uniform pricing of corporate bonds and derivatives by providing a key benchmark. This would in turn help to standardize financial products across the EU and make markets more transparent and comparable.
Second, it would represent safe collateral, useable across all EU member states and market segments, as well as by central counterparties and in interbank liquidity exchanges, including on a cross-border basis.
Third, it would provide a large, liquid market attractive to investors globally. This would mean lower costs of capital and more efficient financial markets across the EU. Because the asset would likely be included in the international euro reserves held by other central banks, the role of the euro as a reserve currency would also be enhanced.
Finally, at the retail level, it would provide all European households with a safe and liquid asset accessible at a common price, while further reducing information asymmetries and “home bias” in the allocation of retail funds. This last point is perhaps where the key challenge for Europe lies: the ongoing tension between national and regional interests when coordinating policy for 27 nation states.
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